It's one thing for European politicians to repeatedly assure the worried masses that the euro zone debt crisis is under control, that more than enough capital will be available to keep the more fiscally challenged members afloat and that there is no danger of any bond restructuring. That, after all, is their job. The idea is to restore market confidence, which, in turn, brings down borrowing costs. If cash-strapped governments can refinance at something approaching manageable rates, they may yet muddle through.
It's quite another thing for people to actually believe it.
Yet signs that investors are becoming less fearful of a euro-area disaster are cropping up all over the place. Spreads on bonds issued by the more bedraggled euro members have narrowed noticeably. Spain's benchmark 10-year bond yield fell on Friday to just over 200 basis points above comparable German debt, the smallest spread since November. And credit-default swaps, that valuable gauge of institutional fear, have fallen sharply across the landscape. Even Greece, with its black fiscal hole and strike-a-day labour woes, saw swaps decline last week to their lowest level in nearly three months.
The bond rally among the downtrodden prompted German Finance Minister Wolfgang Schaeuble to insist there is no need to rush into any plan to bolster the EU's rescue fund or to toughen fiscal rules.
But even if an investor is confident that the Europeans will manage to patch the visible cracks in the monetary union, this is not the time to be hunting for bargains in the sovereign debt pile, warns Simon Ballard, a senior credit strategist with RBC Dominion Securities Inc. in London.
Not even when you can latch on to, say, Portuguese bonds with yields approaching 7 per cent?
"On the basis that Portugal is not going to collapse and the euro is not disappearing, then yes, it offers a very nice yield in an environment where base rates are so low on either side of the Atlantic," Mr. Ballard said the other day on a visit to Toronto. "The problem with buying into European peripheral sovereign debt at this juncture is the mark-to-market risk over the course of the next six to 12 months. If you can take that risk, then, yes, you're getting a very nice running yield. But the volatility that you'll have to digest could be quite extreme."
As an example that all is not what it seems across the pond, he points to the first Portuguese bond auction of the year. Officials labelled it a huge success, because the two issues of bonds maturing in 2014 and 2020 were oversubscribed. "The success of today's issue shows that Portugal has the necessary conditions to finance itself in the market at prices that are not only acceptable, but favourable in the current climate," Finance Minister Fernando Teixeira dos Santos crowed.
Hey, when your finances are in worse shape than those of the average developing country, a yield of 6.7 per cent (on the 10-year bonds) might seem reasonable. And just look at the market demand! But as it happens, the European Central Bank (ECB) had been snapping up Portuguese bonds in the secondary market the day before the auction. So what we saw during the sale itself "was a massive rush [by speculators]to short-cover," Mr. Ballard said. "It was effectively market manipulation [by the ECB] If an investment bank had done it, they would probably be up in front of the SEC for fraud."
This was not the first such intervention by the ECB, whose actions lead to the inescapable conclusion that "all is not right. It's all being held together by [monetary]stimulus and support packages. It's a life support machine that's keeping us going for the time being," he said. And it can't be shut off until the EU addresses the fiscal and other structural imbalances that have widened the gulf between the core "have" countries and the peripheral "have-nots."
His advice is to steer clear of European government and bank debt until the fog lifts. Instead, the focus for bond investors in Europe should be on non-financial corporate names.
Mr. Ballard favours multinationals whose earnings bases are geographically widespread. Investors have been shunning some solid European companies, because they happen to be based in the hard-hit peripheral zone.
The list includes Spanish telecom heavyweight Telefonica, which derives close to 70 per cent of its cash flow from outside its home base and has a growing footprint in Latin America. Greek telecom player OTE is 30-per-cent owned by Deutsche Telekom, giving the latter effective control. "So it's German risk really, with a Greek flavour."
Such companies are good value now, and spreads are likely to widen even further in coming months. "These are the sort of names that we are looking to bottom-fish between now and the middle of the year."